Sunday, 23 March 2014

The FT has a very good article from Tim Harford today, surveying behavioural economics and asking some important questions about it. People within a field can be so immersed in their unconscious assumptions and practices that it takes an outsider to point out some of the questions they are not asking.

Tim says:

The past decade has been a triumph for behavioural economics...[which] is one of the hottest ideas in public policy....Yet, as with any success story, the backlash has begun. Critics argue that the field is overhyped, trivial, unreliable, a smokescreen for bad policy, an intellectual dead-end – or possibly all of the above. Is behavioural economics doomed to reflect the limitations of its intellectual parents, psychology and economics? Or can it build on their strengths and offer a powerful set of tools for policy makers and academics alike?

Quite. That, of course, is a journalistic question - not one intended to be answered within the article, but designed to provoke the prospect of a good ding-song. But the substantive points come soon. Note that Tim, writing for a generalist FT-reading audience, chooses to address his article to public policy so it doesn't look like an abstruse argument between academics. But actually it's about the effectiveness of BE, and economics in general, as a tool at all. Public policy, private decisions, how businesses operate - all can be informed by whatever economic theory we believe in.

...there is something unnerving about a discipline in which our discoveries about the past do not easily generalise to the future...This patchwork of sometimes-fragile psychological results hardly invalidates the whole field but complicates the business of making practical policy.

Indeed - and it divides the field, into those who believe a (more) unified theory is available, and those who believe rational choice is still the main theory available and that behavioural results are only meaningful in relation to that.

The line between behavioural economics and psychology can get a little blurred. Behavioural economics is based on the traditional “neoclassical” model of human behaviour used by economists. This essentially mathematical model says human decisions can usefully be modelled as though our choices were the outcome of solving differential equations. Add psychology into the mix – for example, Kahneman’s insight (with the late Amos Tversky) that we treat the possibility of a loss differently from the way we treat the possibility of a gain – and the task of the behavioural economist is to incorporate such ideas without losing the mathematically-solvable nature of the model.

Consider the example of, say, improving energy efficiency. A psychologist might point out that consumers are impatient, poorly-informed and easily swayed by what their neighbours are doing. It’s the job of the behavioural economist to work out how energy markets might work under such conditions, and what effects we might expect if we introduced policies such as a tax on domestic heating or a subsidy for insulation.

And the problem today is that, without a clear theory, behavioural economists can't work that out. All they can do is suggest various effects that might happen, and design an experiment to test them. Nothing wrong with that, but it's a bit ad hoc.

The most well-known critique of behavioural economics comes from a psychologist, Gerd Gigerenzer of the Max Planck Institute for Human Development. Gigerenzer argues that it is pointless to keep adding frills to a mathematical account of human behaviour that, in the end, has nothing to do with real cognitive processes.

David Laibson, a behavioural economist at Harvard...concedes that Gigerenzer has a point but adds: “Gerd’s models of heuristic decision-making are great in the specific domains for which they are designed but they are not general models of behaviour.” In other words, you’re not going to be able to use them to figure out how people should, or do, budget for Christmas or nurse their credit card limit through a spell of joblessness.

We come back again to the need for a general theory, and one of behavioural economics' regular combatants agrees:

For some economists, though, behavioural economics has already conceded too much to the patchwork of psychology. David K Levine, an economist at Washington University in St Louis, and author of Is Behavioral Economics Doomed? (2012), says: “There is a tendency to propose some new theory to explain each new fact. The world doesn’t need a thousand different theories to explain a thousand different facts. At some point there needs to be a discipline of trying to explain many facts with one theory.”

The challenge for behavioural economics is to elaborate on the neoclassical model to deliver psychological realism without collapsing into a mess of special cases...The question is, how many special cases can behavioural economics sustain before it becomes arbitrary and unwieldy? Not more than one or two at a time, says Kahneman.

Thaler says: "...if you want one unifying theory of economic behaviour, you won’t do better than the neoclassical model, which is not particularly good"

It seems that Kahneman and Thaler actually agree with Levine in a way; all three doubt that behavioural economics can crystallise into a single theory, though only Levine thinks this is a serious problem.

George Loewenstein and Peter Ubel wrote in The New York Times that “behavioural economics is being used as a political expedient, allowing policy makers to avoid painful but more effective solutions rooted in traditional economics.”

This point is different but important: if policymakers expect behavioural economics to be a substitute for regular economics they'll be disappointed. The two are complementary, and the most important policy contribution of BE may be to tell us which economic incentives will have the biggest impact, and which will have unwanted side-effects, rather than to obviate the need for traditional incentives altogether.

Should we be trying for something more ambitious than behavioural economics? “I don’t know if we know enough yet to be more ambitious,” says Kahneman.

That's a provocative point. Yet it acknowledges that whatever field eventually manages to incorporate both traditional and behavioural economics may have to be called something different.

Laibson says behavioural economics has only just begun to extend its influence over public policy. “The glass is only five per cent full but there’s no reason to believe the glass isn’t going to completely fill up.

I and many readers of this blog will probably be with Laibson on this point. But perhaps without a new approach, behavioural policy is going to run more and more often into the wall of adhockery - the lack of general theories making us redo things from the ground up in each new situation.

Tim isn't the only person to write about this recently. For a contrary word, try Chris Dillow's comment, which makes some good challenges from his usual half-libertarian, half-Marxist point of view.

Then, here are some links and thoughts from Diane Coyle, including "Is behavioural economics the past or the future" by Chris House. Diane hones down one of Tim's questions into Kao and Velupillai's distinction between classical and modern behavioural economics: modern assumes people are (biased) optimisers, while classical assumes they are satisficers. This is the same distinction drawn by Gerd Gigerenzer, though his research looks at a broader range of decision-making heuristics, of which satisficing is just one. Diane asks, effectively: is the best mathematical approach to tweak the models of maximisation, or to try to build a new behavioural economics based on heuristics?

Chris House's post says:

...in 2007-2008 we were again told that behavioral economics would finally come into full bloom. It didn’t happen though. The wave of behavioralists never came.

While this isn't true in psychology or behavioural policy and marketing - all thriving and fast-growing fields - it is true of economics. My experience is that many new economics undergraduates or entrants to economics PhD programs are intrigued by behavioural ideas, they are often guided by supervisors into more traditional areas where it is easier to define a research question that is going to produce safe, publishable papers. Barkley Rosser, commenting on House's post, mentions the new journal Review Of Behavioural Economics, which along with other emerging initiatives may help to change this.

Otherwise, Chris raises that same point:

Behavioral economics won’t get very far if it ends up being just a pile of “quirks.” Are these anomalies merely imperfections in a system which is largely characterized by rational self-interest or is there something deeper at play? ...if behavioral is to somehow fulfill its earlier promise then there has to be some transcendent principle or insight which comes from behavioral economics that we can use to understand the world.

For most decisions of interest to economists these external helpers [computers, paper and pencil etc] play a critical role – and no doubt lead to a higher level of rationality in decision making than if we had to make all decisions on the fly in our heads.

What a brave claim! Do we really rule out from the realm of economically interesting decisions all consumer purchases, the consumer's intuitive feelings about how safe they feel with a certain amount of savings in the bank, and all the decisions about cars, houses and jobs that - although someone might sit and think about them for a while - still involve a big chunk of emotion?

Actually, there is no need to throw out these kinds of decisions in order to meet Levine's key challenge of "trying to explain many facts with one theory." He asserts that mainstream economics is already successful at explaining many facts. But perhaps, when he discards all those "uninteresting" decisions it isn't so hard to explain what's left.
Indeed, it's those "uninteresting" decisions which classical economics does struggle with, and only behavioural economics can illuminate. Contrary to Levine, I am convinced that these decisions actually make up the majority of important economic events. But I do recognise his critique - echoed by Tim and implicitly by Velupillai and Gigerenzer: that behavioural economics does not offer a full theory to replace that of mainstream economics. However, it has given us good empirical evidence which we could build a theory on.

As well as defining away a large portion of the economy as "not interesting", Levine also co-opts some of the parts that he does consider interesting, saying they are already handled by mainstream economics: notably the subject of learning. Non-behavioural economists have considered consumers' imperfect ability to learn the preferences of other consumers, or the rules of the "game" they are playing, as a factor in non-optimal decisions. But psychologists know much more about exactly how people learn than economists do - so a successful model of learning as part of economics can only be built with an openness to psychological research. Where Levine may be right is that behavioural economics will not replace mainstream economics, but instead the two fields will merge - with the behaviour of consumers predicted by a combination of objective economic, and subjective psychological, factors.

Anyway, arguments over the boundaries of disciplines are rarely productive: I don't really mind if Levine considers a model to be behavioural or not, as long as the model advances the cause of making successful predictions.

The real questions are: does standard economics fail to address some important problems? How good is behavioural economics at addressing them instead? And does behavioural economics need a unified approach in order to address them?

Most of the people mentioned above have different answers to those questions:

Levine wants a unified theory - but think we have to exclude many types of "uninteresting" decision in order to get one.

Kahneman and Thaler want different theories for several different areas - but those incompatible theories will not be able to deal with the many boundaries where different aspects of economics interact with each other.

The classical economists already have a unified theory - but there are many things it can't explain.

Gigerenzer has a philosophy - but no overall theory. And I'm not sure if he expects or really wants a unifying theory any more than Kahneman does (this may be one of the few things they agree on).

My view, which I think concurs with Laibson's: a single broader theory is possible. I think we've hit a theoretical dead end with the traditional maximising agent, so it will have to be based on more psychologically realistic foundations, such as those of Velupillai, Gigerenzer or Bettman, Payne & Johnson. To achieve this, we need to carefully choose the right elements to build into our model of decision-making in a way, so that it can make useful predictions of how those elements might operate. I have a paper coming out later this year which suggests one direction towards this.

I started a new business, The Irrational Agency, with a business partner. We've taken the ideas of behavioural economics into the market research and marketing worlds, and tried to go a bit deeper than some of the agencies who appear to have based their behavioural services on reading the first half of Predictably Irrational. We've developed a decision process model (based on some ideas regular readers might have seen on here last year) and been lucky enough to work with some quite cool clients to apply it.

I developed my theory of cognitive microfoundations a bit further. It's now primarily based on information processing and attention, informed by a range of empirical decision-making work and on some theoretical work from the likes of Payne, Bettman and Johnson and the adaptive toolbox of Gigerenzer and Todd. I've taken the ideas forward at two workshops – the Summer Institute on Decision Making at the Max Planck Institute, and the EADM JDM Young Researchers' Workshop.

There has been some development of similar ideas by other economists too: Xavier Gabaix and Michael Woodford for example (more on their work in a post from the AEA conference soon).

I've presented at a few academic conferences - ICP, ICT, SJDM, SPUDM...and some other places like the Professional Pricing Society and conversionsummit

A few ideas on intangible products have started to emerge - first into a pricing workshop and maybe into a new book next year.

I've visited India, Cuba, South Africa, Canada, the US, Spain, Germany, Switzerland, Estonia, Finland and Denmark to follow all these ideas through and meet a bunch of pretty exciting people.

(A microfounded model might start off like this: "Imagine N agents, each of which has income yn, consumes cn and saves sn. Then yn = cn + sn. For each agent, sn varies with the interest rate r according to the following relation..." while a non-microfounded model is more likely to start: "Total spending in the economy is C and saving is S. C+S must sum to Y, total income. S varies with the interest rate r...")

But does the microfoundations approach really work? It seems a good idea in principle. It works well in some other fields like physics and chemistry (though less so in biology). Building things from the ground up protects us against falling into certain mathematical traps. Some concepts (like the idea of people trading different goods with each other) don't really even exist at the aggregate level, so are hard to talk about without microfoundations. The idea that we can understand things in this level of detail is an appealing one.

Unfortunately, the idea of microfoundations has come to be closely associated with rational agent theory. Most microfounded economic models are implementations of DSGE (dynamic stochastic general equilibrium), which assume a population of rational utility-maximising agents who are given certain preferences and resources and respond logically to those. Readers of this blog, or of any behavioural economics book, will be unsurprised to hear that real people do not maximise utility in the way DSGE models insist - as demonstrated in numerous psychology experiments. Economists usually respond to this objection in one of two ways, neither of them quite satisfactory.

Response one: to claim that rational utility maximisation is close enough to the truth to describe the economy reasonably well. Sure, there are exceptions: people might not always discount future earnings in a consistent way, and sometimes we buy things because they’re on sale and not because our utility from the product exceeds the price paid - but those are minor errors, they mostly cancel each other out, we learn to be more rational over time, and the limits imposed by our income force us to act fairly rationally. So, DSGE models, maybe with a couple of small tweaks, are still the best way to describe the economy and work out how to manage it. We can still make inferences about how tax rates will change the choices of individual workers, or how interest rates will affect investment and savings decisions, and draw conclusions from that about how the whole economy will evolve.

Response two: to agree that individual rational agent models are too far from the truth to be useful but then to give up. For many, the failures of economic forecasting in the leadup to the 2008 crisis prove this. There are better ways to describe individual decisions - behavioural economics gives us some hints - but these are mathematically too hard to build models with. Therefore we shouldn’t bother with microfoundations - instead, we should reason from aggregates, such as the total amount of money, production, employment and debt in the economy. It is possible to work out, for example, that if companies try to save more money (as we can see they currently are), individuals try to pay off their debts (as they are), and governments try to cut their deficits (as they say they are) something must give. The model may not tell you which one will fail, but it can tell you that something must. These models can’t describe all economic phenomena because the aggregates don’t always tell you enough, but maybe they are all we have.

The first response is wishful thinking. The second is fatalism.

What if there is another way? Maybe, by choosing the right models from cognitive psychology and behavioural economics, and aggregating them in the right way, we can develop an accurate representation of large-scale systems after all. Then perhaps we can get the benefits of a microfounded model - which lets us understand many different economic phenomena, and gives us confidence via experiments that its conclusions are sound - but with greater accuracy, predictive power and robustness than today’s DSGE models.

Such models, microfounded not on rational utility theory but on real cognitive processes, might focus on specific domains such as consumer product markets or labour markets. They might let us explore the effects of specific economic policies such as tax or interest rate decisions. Eventually, they might develop into a unified theory that can be used to investigate any aspect of the economy - the cognitively sound equivalent of Arrow-Debreu general equilibrium theory.

Can this be done? It’s too early to say for sure, but it’s one of the most important questions for the economics discipline to ask itself.

So this year I’m going on tour. I will travel to wherever I can meet researchers in different economic domains and work out with them how psychology can be incorporated into their models. Although it might be possible to work out cognitive microfoundations from first principles, I suspect it will be more practical to start asking what kind of foundations will illuminate each different economic domain.

My initial objective is to work with people in each of the following disciplines:

Consumer behaviour

Competition and market organisation

Labour economics

Trade and international economics

Fiscal policy

Development economics

Monetary theory

Industrial organisation

Personal finance

Financial markets and asset pricing

Environmental economics

Health economics

I have a few collaborations lined up already, but there’s no restriction to just one in each field. So if you work in one of those areas - or would like to propose another - get in touch and I can add your location to my itinerary.

Both quotes reveal a simplistic view of the nature of choice. It’s as if our choices are fixed – and we will always make the same choice unless there is some barrier in the way. The New Yorker assumes that each of us either definitively wants to be single or wants to be married, and that we’ll get our way unless something thwarts us. The debate over Mulligan's claims, on the other hand, take literally the fact that we have free will – so if someone laid off from a Detroit factory or a Texas high school has chosen not to take the minimum wage job at Walmart, their unemployment is voluntary.

Mulligan’s view is often mocked – Ryan Avent calls it “The Great Vacation” (did he coin the phrase?) – but it does at least have some internal consistency. People intuitively object to this story because it seems to imply people’s preferences have changed, and they have just decided they now want more leisure. But in fact this model assumes that preferences are exactly the same, and it’s the available options that are different. Simon Wren-Lewis writes here:

"In RBC models, all changes in unemployment are voluntary. If unemployment is rising, it is because more workers are choosing leisure rather than work. As a result, high unemployment in a recession is not a problem at all. It just so happens that (because of a temporary absence of new discoveries) real wages are relatively low, so workers choose to work less and enjoy more free time"

One defence of Mulligan is to read his claim more narrowly: that unemployment benefit reduces people's desire to work by a bit, increasing unemployment by an unknown amount - which seems plausible - and not that the whole recession arises from this cause.

Regardless, the right approach to both claims - that unemployment is voluntary or that Americans are forced to be single - is that people's actions are a result of both our individual wants and the environment we find ourselves in. Our wants might indeed change over time – though this tends to be a slow process. Our choices change much more quickly, because the same person in a different environment will make a different choice from the same options. A man with £10 in McDonald’s may choose to eat, while a man with £10 in Gordon Ramsay’s may choose not to eat (even though technically he could buy something from the lunch menu). The man is the same, and his budget is the same, but his actions are different.

Even the idea of “the same options” is dubious. Has the man in Gordon Ramsay’s really been offered “the same options” as the man in McDonald’s? Is a worker turning down a cashier job in Walmart choose from “the same options” as a worker taking a project management job at Boeing? Economics is partly about abstracting away the differences between different situations, but we must recognise when we’re abstracting too much.

Standard economics takes us up to about this point, and Noah Smith says as much in this post. Each person has preferences which determine the relative exchanges they’re willing to make. These preferences define a particular value for my time – £20/hour – so that if the wage offered (adjusted a little to take account of employment terms, location etc) is greater than £20/hour, I’ll take the job; otherwise I’ll stay at home. Similarly, my preferences may determine that the effort and sacrifice of being in a couple has a certain cost to me, and only if the benefits outweigh that cost will I enter a relationship. Thus, I may be more willing to go into a relationship with a person who I find more attractive (thus increasing the benefit of the relationship) or if housing prices rise (increasing the cost of staying single).

The psychology of decision-making says things aren’t this simple. The factors that determine the cost and benefit of each option are not stable. My preferences fluctuate according to how I feel, and my perception of the options I’m choosing between will change according to what I’m thinking of, what I’ve been reminded of, and what I’m looking at. Some factors become more important because they are more salient, and others may be ignored altogether.

Some particular factors become important to me which, according to a rational utility model of choice, should not matter at all. For instance, the wage I was paid last month should not be relevant to whether I accept a job at Walmart this month. But you can be sure it will be. There are a whole range of possible reasons for this: I may have mortgages and bills to pay that require me to earn over a certain level; I may treat my last wage as a signal of what I’m likely to be able to earn if I hold out for a better job offer; or I might simply feel ashamed to accept a 50% cut in pay. Whatever the reason, either my preferences, or my beliefs about the context I’m in, or both, are now seen to be dynamic and not static.

This means it is too simple to say “my preferences have changed” or even “the environment has changed”. Both are always changing. My choices are constructed in each moment out of the information available to me from inside and outside my mind.

There is not even a clear distinction between preferences and context. My preference to work at £21/hour instead of staying at home is in turn influenced by the context I live in, in particular the level of my mortgage payments or whether I think the economy is getting better. So the choice is in fact a tradeoff between one external factor (the job offer) and a series of others (mortgage, economy) with my mind as the calculating device that sits in between, weighing up the factors.

My mind of course is not perfect, and it can only roughly estimate the strength and future path of each factor. So it relies (I rely) on rules of thumb, heuristics, to save time and make it possible in practice to actually make any decisions at all. Those heuristics themselves can change over time, as I have new experiences which I learn from – and which may invalidate old heuristics or lead to new ones. Maybe the last time I took a low-paying job, in high school, my brother got a better one the following week, and laughed at me. The heuristic that I might learn from that is fairly clear, even if I’m not conscious of it when I make my decision now. If I turn down this job and don’t get another offer for three months, perhaps my heuristic will change.

Can we even distinguish between heuristics, preferences and environment? Not clearly. From the outside we cannot tell whether the man turning down the Walmart job is doing so because he has a clear, conscious preference for a £20/hour job, or whether he’s subconsciously applying a rule of thumb his brother taught him by teasing 20 years ago, or whether he simply cannot afford to work for less because it won’t pay the mortgage and he has to hope for a better offer next week. Even internally, the man himself probably does not clearly know the difference between these three causes. So is it meaningful to say that they are three distinct phenomena?

We haven’t even discussed the signalling and cultural implications of taking a job at Walmart, or the influence of the way in which the offer is communicated (“We’d really appreciate if you’d take this job, to help us to serve your community better” or “Head Office has approved your application for employment, and subject to security and identity checks you may arrive on Monday at 8am sharp.”). Language and culture too shape our interpretation of the choices we are offered and the factors that we take into account; this can be seen as part of the cognitive process or as part of the environment in which we choose.

We are left with two ways to think about choice. The first option is to declare the process of choosing to be too complex for simple interpretations like “unemployment is voluntary” or “Americans are single because they have no choice” to be entirely true (or entirely false). The second option we can find a new and more accurate abstraction to describe choice – I like to think of it as “a cognitive algorithm which translates external and internal signals into actions”. In this view, the idea of voluntary unemployment or involuntary singledom simply lose their meaning. The very term voluntary becomes moot.

Then, did the unemployed man jump or was he pushed? All we can say is that a confluence of factors - physical, or emotional - and his response to them, caused his fall.

Where, then, has free will gone? Was it ever there in the first place? That must wait for another post.

Tuesday, 20 March 2012

The first time you heard them they were quite fun, memorable even. But then they got more airplay. And more. And more. Radio stations figured out that the sugary, bubbly popness of the tunes would cut through a lot of background noise and get your attention, so they played them again and again. Soon we had Got To Be Certain, and Je Ne Sais Pas Pourquoi, which were exactly the same as the first two songs. Then a "strategic inter-agency collaboration" with Jason Donovan on Especially For You. (Jason looks a bit less lifelike in this alternative version).

After a short interlude in late 1989, another number 1 with Tears On My Pillow, which was meant to be more sophisticated but was equally artificial, overproduced and in fact just the same old song as I Should Be So Lucky. By this time anyone who wasn't a 13-year-old girl was thoroughly sick of Miss Minogue, who wasn't even on Neighbours any more. Interest and record sales rapidly declined, and thankfully Nirvana showed up to distract us.

On a completely unrelated subject, do you remember those talks about behavioural economics that infected the market research industry in 2009? Someone had read Nudge, and someone else got a copy of Predictably Irrational. It's quite easy to write a behavioural economics talk - you just claim that everyone else in the world thinks people are irrational, but you have spotted (with the help of Daniel Kahneman perhaps) that they're not. Read out a list of cognitive biases - anchoring, hyperbolic discounting, social norms. Show some slides with illustrated examples of each bias. If you're brave, test one of them on your audience and hope they haven't yet been to enough identical talks to see through your ultimatum game or your auction. I am just as guilty of this as anyone else.

As straightforward as this formula is, it's no surprise that throughout 2010 and 2011 you've had the opportunity to attend perhaps twenty workshops, panel discussions and seminars every year containing exactly the same content. Every Market Research Society conference since 2009 has had a behavioural economics session. Every agency has sent one director and two junior researchers to a training course. Every agency at the top of the GRIT rankings has a behavioural economics link on its website or its case study at ESOMAR.

(Don't get me started on feckingneuromarketing.)

The backlash was smooth, professional and equally predictable. "But isn't behavioural economics just what good marketers have been doing all along? This theory is all very well, but how do we use it? Cognitive biases are all very well in the lab, but how do you know the results apply to consumers in the real world? Anyway, it's all just a fad."

Put any three market researchers in a pub and mention behavioural economics, and I guarantee the conversation will proceed swiftly along the above lines.

But wait one second.

It's 2000. Kylie hasn't had a number 1 single for ten years, or even a top ten hit since 1994. She's a joke. She's been dropped by her record label. There isn't even a nostalgia industry around her yet. In fact, Nicole Kidman's the only Australian we recognise now.

Paula Abdul writes a song but decides not to record it. It is hawked around the industry and eventually gets passed on to Kylie.

Spinning Around is a worldwide hit, number 1 in the UK and Australia, and revolutionises Kylie's career. The theme of the song reflects Kylie's own transition: she's grown up. No more novelty singles or soap opera posing. She's sexy now.

Behavioural economics is ready to grow up too. Enough with the cognitive biases, the party tricks. The field is actually based on much deeper psychological research into judgement and decision-making, cognitive theory and information processing. It's time to abandon the false tension between "rationality" and "irrationality". Our minds process information and choose actions in a way that is locally rational. But when viewed globally, these choices show that there are conflicts between the different interests and needs that a single human being has.

Behavioural economics, and the cognitive theories that underpin it, gives us insight into how people interpret the world, what people want, and the actions people take in response. It invalidates traditional methods of market research and marketing cliches - but only once it is taken seriously. It tosses out the basis of conventional economics, consumer preferences - and the very notion that we make "decisions" between "products".

There is a proper, integrated theory here, based on the idea that people adapt to a basic level of satisfaction, and act to restore it when it is disturbed. They rely on efficient but imperfect memory to retrieve a variety of strategies to restore that homeostatic equilibrium, and only when those strategies lead them towards product acquisition do they apply something a little bit like a standard consumer choice process - but one constrained by the brain's information processing limits. Experimental psychologists can help you design experiments to measure each of these stages, and you can design interventions to change the behavioura of the average consumer at each point.

Yet we only have access to these insights once we stop playing at party tricks; stop pretending that people are really rational except when we pull the wool over their eyes with a clever heuristic. Only when we use a well-founded model of cognition and design our research methods to uncover its parameters, will we be able to predict, and more importantly influence, what consumers do.

Behavioural economics has a new record company, and it's about ready for its serious phase. Time to reinvent it. That complex, but scientifically measurable, cognitive model is what runs your mind, and you can't get it out of your head.

Saturday, 31 December 2011

During 2011 I have probably spent about four days waiting for my browser to respond, due to the number of tabs I habitually keep open. Between the four computers I use, I probably have 200 blog posts in tabs waiting for me to comment. Here are a few of them (in no particular order), so my Chrome may enjoy a faster 2012.

A note from Paul Krugman on what makes economics economics. Not a rhetorical discipline but one based on mathematical models. (However, see also Deirdre McCloskey's Knowledge and Persuasion in Economics, which puts forth a persuasive case that it is both. Also, I believe that rhetoric, culture and all forms of speech will one day themselves be modelled within economics - a tantalising prospect).

Talking of persuasion, here is Steve Randy Waldman on market monetarism, and whether we can fix recessions by simply persuading people to change their economic expectations, or whether there are real constraints that can't be solved just by monetary easing. I could plausibly have picked any article on his interfluidity blog as article of the year (if I were doing an article of the year), but this quote alone shows more insight than most entire blogs: "Central banks may significantly shape patterns of consumption and investment by choosing to whom they are willing to lend and on what terms. They may pick winners and losers, not for a brief Paul Volcker Chuck Norris moment but for the indefinite future."

The limits of the scientific method in economics (see also part two): an article whose conclusions I don't agree with, but which asks the right question: can economics model (and predict) the behaviour of people whose behaviour is itself influenced by economics? In answer, Roger Martin claims that we can't use deduction or induction to predict the future, only to model the past; to look forward we must use "abduction", or "invent a new hypothesis". This seems a very nihilistic, not to mention impractical, view. He too calls on rhetoric and postmodernism, but unlike McCloskey, who analyses what those things actually consist of, Martin simply attempts to use them as a get-out clause from the anti-scientific logic of his argument.

Mark Thoma's more economics-friendly response to the above. His response to Martin's question, pointing out how the field of rational expectations was invented to answer it, and defending economists' work in coming up with new models as the old ones are proved wrong, is much more to my liking.

An article from the Economist's Blighty blog about behavioural economics - or, more precisely, behavioural social policy and behavioural politics. Despite co-opting Nassim Nicholas Taleb as a behavioural economist - believe me, we don't want him - this piece has some good insights into psychology and why so-called "irrationality" (let's call it "fast heuristics" instead, shall we?) isn't always a bad thing.

Also from Mark Thoma, a quote from Keynes to the effect that society can only build railways and other bits of infrastructure when it participates in a shared illusion that enables it to invest, not consume, the fruits of its wealth.

Some excerpts and a review in the New York Review of Books by John Lanchester of Michael Lewis's Boomerang, including possibly the quote of the year: "you have a dog, and I have a cat. We agree that each is worth a billion dollars. You sell me the dog for a billion, and I sell you the cat for a billion. Now we are no longer pet owners but Icelandic banks, with a billion dollars in new assets". I haven't yet read the book itself, but I'm interested in its attempts to explain economic differences - and similarities - by reference to local culture. As Lanchester says, "The collective momentum of a culture is, for more or less everybody more or less all of the time, overwhelming. This is especially true for anything to do with economics". He draws a broadly downbeat conclusion, but I believe the real need - and opportunity - is to analyse what culture is and how it affects economic behaviour - at which point we might be able to figure out what to do about it.

See if you can boil this FT article about crowds, behavioural economics and neuroscience into nine insightful, factual sentences while ignoring the rest of the silly oversimplifications.

Of course, the time I've spent writing this article far outweighs any browser speedup I am likely to earn over the next twelve months - especially taking into account the forty further tabs I will undoubtedly open over the next week. But I hope you've found the links useful in helping waste some of your own valuable time.

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About this blog

This blog is about cognitive and behavioural economics. It discusses their impact on economic theory, and how to apply them in business, especially in pricing and marketing. It also explores how our perceptions and mental models affect the macroeconomy.

My other blog is Pricing Revolution, specifically around innovative pricing models and advice on how businesses can set their prices.

Other things I do

As well as writing this blog, I am chief executive of Inon Pricing Advisers - which uses behavioural economics and psychology research to help companies charge the right prices for their products. Please click through to find out more.

I am also founder of think tank Intellectual Business which publishes research and policy papers on how ideas from economics can be used in business and in the public sector.